Should you join Lending Club?
Not long ago Renaud Laplanche had workers smash a hole through the floor of his downtown San Francisco office and build a staircase to some newly leased space below. As he led me down the stairs recently for a tour, the soft-spoken, French-born CEO and co-founder of Lending Club, the largest player in the red-hot business of peer-to-peer lending, gestured to the rows of new desks and marveled at his company’s rapid growth, “We’re just getting so big!”
The numbers bear that out: Lending Club issued $173.4 million in consumer loans in July, a 288% jump over last year. But the company’s public profile might be growing even faster than its business. Originally launched as one of Facebook’s first applications back in 2007, Lending Club has emerged as the most successful of a series of startups — Prosper is another — that have attempted to disintermediate banks by connecting borrowers directly with lenders.
The novel business model has attracted both big-media attention and big-name backers to Lending Club. The board, for instance, includes heavyweights such as former Morgan Stanley CEO John Mack, Kleiner Perkins partner Mary Meeker, and former Treasury Secretary (and possible future Federal Reserve chairman) Lawrence Summers. A recent investment led by Google valued the company at $1.55 billion. Lending Club appears to be on track for an IPO next year — “We will be ready,” says Laplanche — if it isn’t gobbled up by the likes of Google or a major bank first. Meanwhile, the business is set for a new stage of growth: Laplanche, 43, says that later this year he will expand into loans for small businesses.
Does investing money through Lending Club make sense as part of your portfolio? To decide, it helps to understand exactly how it works. Potential borrowers sign up with the site, fill out a profile, and submit their requests. Lending Club vets the requests, assigning them letter ratings between A (low risk) and G (high risk). Most borrowers are people with relatively high credit scores — the average is 710 to 715 — who plan to consolidate debt from credit cards, medical expenses, car loans, and the like. They can request either three- or five-year loans with more moderate interest rates than they’re likely to find through other alternatives. (Borrowing rates range from 6.78% to 29.99%, and Lending Club takes one to three percentage points of each loan, depending on the risk profile.) Only about 10% of the loan requests submitted to Lending Club are approved and posted. Lenders then choose from among the accepted loan requests. “The most popular loans disappear in seconds,” says investor Peter Renton, who pens a blog on peer-to-peer lending called Lend Academy.
Most people who use Lending Club spread their investments out in small increments (the minimum is $25) over dozens of loans to protect themselves against default. (Around 3% to 4% of borrowers default annually, says Lending Club.) Investors can choose to actively shop for loans to fund or they can rely on Lending Club’s algorithms to suggest a group of loans for them at one of three levels of risk (low, medium, or high). While Laplanche says the company will continue to cater to individual investors, today about a third of Lending Club’s investments are made by professional money managers on behalf of clients who want to put a large amount of cash to work. Another third of the loans are fulfilled by institutional investors. For example, the Kenyon College Endowment and the insurance company Forethought Life have each invested money through the site.
Last year board member Mack introduced Laplanche to his old employer, and recently Morgan Stanley began offering Lending Club to its wealth-management clients. Mack is an enthusiastic booster for the product as an attractive vehicle for short-term investment dollars. “I think investors should look at this as some piece of their liquid assets,” he says. “I tell people three-year Treasury bills are going to yield 90 basis points, or they can put money to work with Lending Club and get 4% to 10%, depending on risk.”
To get a firsthand feel for what it’s like to use Lending Club, earlier this year I made a modest investment through the site, using the medium-risk profile algorithm to distribute my funds over a broad range of loans. I liked knowing that my money would support, among others, a person trying to pay off a car loan in Monson, Mass., one town over from where my mother lives. Seven months in, I’ve made a 14.87% net annualized return. To be fair, the returns are typically higher at the beginning of the loan period because borrowers rarely default immediately. Factoring in a default rate of nearly 7% for my risk category — one borrower who got $25 of my money has already declared bankruptcy — Lending Club projects that I will make a 9.72% return over the life of the loans. For a relatively low-risk investment, it’s hard to imagine a much better result.
This story is from the September 2, 2013 issue of Fortune.